Indiana regulators said Wednesday that top executives at Citizens Energy are overpaid and reduced the amount the company can raise rates on hundreds of thousands of water customers because of it.

The Indiana Utility Regulatory Commission also launched an investigation into the company's management practices, including how it runs its billing operations and call centers. The agency said that in some months, one out of four callers to the company hangs up before receiving service because of long wait times.

The action amounted to a stern rebuke by state regulators over the high salaries and incentives pocketed by Citizens executives after the company acquired the city's water system, as well as the level of its customer service.

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Citizens Energy Group president and CEO Carey Lykins poses in the company's Near-Northside building on July 1, 2013.(Photo: Kelly Wilkinson/The Star)

Citizens came under fire last summer after The Indianapolis Star reported that CEO Carey Lykins earned $2.9 million in 2012 — nearly double what he made the previous year and more than triple what the leaders of other large municipal gas utilities earned.

Lykins had defended his pay, saying it was comparable to what executives made at similarly sized, primarily private utilities. But Indiana utility regulators later grilled him in a public hearing, strongly hinting that the executive compensation was out of line.

The regulatory commission said Wednesday the multimillion-dollar salaries were excessive.

"Citizens Water's level of executive compensation was not appropriate for a municipal utility," the agency said in a statement.

It warned that it expects Citizens to realign compensation in its next rate case "so that it is more compatible with actual municipal-based expenses."

A truck brings in heavy construction materials as Clearpath Construction workers continued to fuse 16-inch high-density polyethylene pipe together on Wednesday, March 19, 2014 as construction will start on Edmondson Avenue very soon. The Indiana Utility Regulators said Citizens Energy directors make excessive pay and sharply reduced the rate increase request to repair water lines. Matt Detrich/The Star

Jim Atterholt, chairman of the Indiana Utility Regulatory Commission, holds paperwork related to a request by Citizens Energy to raise water rates by 14.7 percent during their meeting inside the PNC Center, Wednesday, March 19, 2014, in Indianapolis. The request was passed but at a 9 percent increase. Brent Drinkut/The Star

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The utility took over the city's aging water and sewer systems in 2010 for nearly $2 billion, promising to keep rates lower than the city could have done on its own and to provide better service. Mayor Greg Ballard had strongly supported the deal.

Ballard's spokesman, Marc Lotter, said Wednesday the mayor still supports the deal and applauded the IURC as the appropriate mechanism to correct possible excesses or abuses.

"Rates were always destined to go up, because of the aging infrastructure and the need to replace that," Lotter said. "But they were going up much less because of Citizens' management than they would have otherwise."

He said the executive salaries at Citizens was a matter for the company's board and the IURC.

The company asked last year to raise rates by 14.7 percent. It said the system had 730 water main breaks last year, and some sections date to the 1800s.

But the agency, in its 102-page order Wednesday, gave Citizens permission to raise water rates for its 300,000 Indianapolis-area customers by 9 percent. The company said that will translate to an increase of about $3 a month for the typical homeowner.

In a statement, Citizens said the smaller rate increase would create "a shortfall in funds for vital infrastructure investments."

"Years of underinvestment by past owners has resulted in a water system that experiences 700 main breaks per year, resulting in $3.5 million in repair costs and 3 billion gallons of wasted water," the company said.

Citizens said it has already taken steps to address the compensation issue, and will continue to do so. In December, the company said it cut compensation for its top executives by an average 27 percent. Lykins saw his compensation slashed by more than a third, to $1.9 million last year.

Despite the pay cuts, Citizens' payroll grew, according to a review of recent numbers by The Star. Total payroll swelled from $82.3 million in 2012 to $89 million last year, and the number of employees climbed about 4 percent.

Citizens said the higher number of employees was largely due to high turnover rates in various positions, and it counted even employees who stayed only briefly.

In addition, The Star found that the number of employees making six-figure salaries climbed from 94 to 162, or about 72 percent.

Citizens said the higher figure is due to a difference in how it reports its payroll to the state. In 2012, it reported taxable income, but last year, it reported all income, including health insurance and retirement savings accounts.

The company said when equal figures were compared, only about 20 additional employees pulled down compensation of $100,000 or more.

Several outside consumer groups hailed the agency's ruling. David Stippler, the state's utility consumer counselor, said the order "takes important steps in addressing the utility's executive compensation," while making sure that billing and customer service issues are examined.

Citizens Action Coalition, a grass-roots group and frequent critic of utilities, said the action was just.

"We applaud the commission for finally holding Citizens accountable for their outrageous violations of the public trust and the total disregard they hold for the prudent use of ratepayer money," said Kerwin Olson, the group's executive director.

The agency also allowed Citizens to recover investment funds for infrastructure improvement through 2015, which will save ratepayers $2 million.

Call Star reporter John Russell at (317) 444-6283. Follow him on Twitter: @johnrussell99.